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Hard Assets The Place To Be Following US Credit Downgrade

Joel Smolen, hedge fund manager at Axion Capital in San Rafael, says hard assets like gold, silver and equities of mining and metals companies in countries like Australia and Brazil are the places to be following the US credit downgrade.

Lou Gerken of Gerken Capital in San Francisco says gold is going to $2,000 an ounce, an record. It closed Friday at $1,648 for the August futures contract.

“Maybe over the short run Treasurys will be okay, but if you consider what the government backs in terms of state funding then it’s going to hurt municiaplities a lot down the road. Maybe in the next week or two we won’t see much pain, but over the long term you will see a change in market thinking in bonds. I have a feeling that the J&Js of the world and the IBMs and the Apples are going to have a more attractiveness to bond investors because of the cash they carry,” Smolen says, which makes servicing debt a piece of cake.

“It’s not goign to take too many sovereign wealth funds to decide that it’s better to move into gold and silver than dollars, and I think there will be some purchase of equities in hard asset companies in the days ahead,” Smolen says.

On July 12, fund managers polled by Forbes said that they had no confidence in Washington to resolve the fiscal crisis. The best case scenario was a last minute budget deal, with subpar reforms and cutbacks, which is exactly what happened. It’s not that the market wants to shove the US government down the drain, it just wants serious long term tax reform, closure of major tax loopholes that has companies like Google paying next to nothing in taxes, and a raising of the retirement age because people are living much longer than the original Social Security pension system had allocated.

“It is now clear that Standard and Poor’s has no confidence in Washington either,” says Joseph E. Meyer, a former Merrill Lynch broker now running the Straight Money Analysis newsletter. “ The crisis with the Federal deficits, state budgets and the dollar is not ending with the debt bill. It’s just beginning. The role of the dollar moving forward is now in question. The European Union is not pleased with this latest development and the Chinese must now reevaluate their commitment to dollar denominated assets as well. None of the major structural problems in the economy at this point have even begun to be addressed, so simply stated this economy is in deep trouble and the markets now know it,” he says.

The US credit downgrade has added a global dimension on top of the eurozone’s debt crisis in the markets, leading Finance Ministers from the G-7 to call an emergency meeting this weekend.

“The G7 will confer by telephone. It’s not yet confirmed whether it will be in one stage or in two stages, tonight and tomorrow,” a senior European diplomatic source told Reuters. Francois Baroin, France’s finance minister, who would chair such a meeting under the French presidency of the G7 and G20, said in a radio interview it was too early to say whether there would be an early G7 meeting, scheduled for early September initially.

The downgrade potentially changes the monetary relationship between the US and the world’s largest creditor nations, like China, who lend money to the US to support the country’s borrowing. The question is at what pace will they continue to buy US debt and, more importantly, at what interest rate will the market demand now that the US is no longer AAA.

“If interest rates rise, it will break the back of a already very depressed and fragile housing market and increase debt stress on the money center banks,” Meyer expects. ”Hard assets plays are the place to be. I would avoid the government bond market and use rallies to raise cash and reduce exposure to the broader equity markets because this is now a high risk situation.”